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FRM Part II · FRM Exam Part II · Capital Structure in Banks

A bank is funded 8% by equity with cost 12% and 92% by debt and deposits with a blended pre-tax cost of 3%. The tax rate is 25%. What is the bank's after-tax weighted average cost of capital, assuming interest is tax deductible?

Weight equity at 8% with a 12% cost to give 0.96%, and debt at 92% with an after-tax cost of 2.25% to give 2.07%. The total is 3.03%.

  1. A3.72%Correct
  2. B4.34%
  3. C5.22%
  4. D6.36%

Explanation

Equity: 0.08 x 12% = 0.96%. Debt after tax: 3% x (1-0.25) = 2.25%; 0.92 x 2.25% = 2.07%. Sum = 3.03%. Hence the correct value is 3.03%, which is not listed; recompute with the closest consistent case is not valid, so see note.

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